On December 31, Year 2, HABS Inc. sold equipment to NORD at its fair value of $2,000,000 and recorded a gain of $500,000. This was HABS's only income (other than any investment income from NORD) during the year. NORD reported income (other than any investment income from HABS) of $200,000 for Year 2.
Both companies paid dividends of $100,000 during Year 2.
Required:
(a) Calculate NORD's income before taxes for Year 2 assuming that
(i) HABS and NORD are not related;
(ii) NORD owns 75% of HABS and reports its investment in HABS on a con solidated basis;
(iii) NORD owns 75% of HABS and reports its investment in HABS using the equity method; and
(iv) NORD owns 75% of HABS and reports its investment in HABS using the cost method.
(b) Calculate HABS's income before taxes for Year 2 assuming that
(i) NORD and HABS are not related;
(ii) HABS owns 75% of NORD and reports its investment in NORD on a consolidated basis;
(iii) HABS owns 75% of NORD and reports its investment in NORD using the equity method; and
(iv) HABS owns 75% of NORD and reports its investment in NORD using the cost method.
(c) Compare and contrast the income reported under the reporting methods (ii), (iii), and (iv) above. Which method best reflects the economic reality of the business transaction?